Business Directories

BAE-EADS $60bn merger plan faces risks

London, September 14, 2012

The potential $64 billion merger between UK defence contractor BAE Systems and European aerospace group EADS, aimed at creating the world's biggest defence and aerospace group, could run up against political and regulatory obstacles.

If talks unveiled late on Wednesday culminate in a deal, BAE shareholders would hold 40 percent and EADS investors 60 percent in a giant with products ranging from Airbus commercial planes to Typhoon warplanes and BAE's Astute-class nuclear-powered submarines.

Potentially the biggest shake-up in the European aerospace and defence sector in a decade, it would underline the push by defence firms to offset the impact of shrinking national military budgets with more revenues from the commercial sector.

But the accord will need the backing of Germany and France to unravel the 12-year-old shareholder pact underpinning the strategic European aerospace champion, while the enlarged group must win the trust needed to deal with security-minded customers from the Pentagon to the Gulf.

With European politicians wary of the possible impact on jobs - especially in France where unemployment has reached 13-year highs - the head of EADS' Airbus unit sought to reassure staff that a deal was designed to strengthen their company.

"Such a combination would strengthen EADS and BAE Systems - thereby making Airbus part of a stronger company overall," Fabrice Bregier said in a letter to employees, adding that any deal would not affect Airbus' organisation, product plans, manufacturing or future strategies.

"A merger would allow EADS to achieve its aim of balancing civil aerospace ... with non-Airbus activities," Citigroup analysts said in a note.

"However, we believe that achieving merger synergies for the combined entity could be difficult, particularly given the need to ring-fence certain strategically sensitive activities," they added, downgrading EADS' shares to "neutral" from "buy".

Ratings agency Fitch said the tie-up had "sound industrial logic" but noted it would require the approval of regulators in France, Germany, the United States, Britain and Saudi Arabia.

"Considering the complexity and security sensitivity of some defence contracts, this may prove to be a long and arduous process," it said.

Western defence spending is under severe pressure from public finances on both sides of the Atlantic, forcing Europe's two largest defence companies to rethink strategies for growth.

"I think it is now recognised that you can't sustain a global defence company off the budget of a medium-sized or even large-sized European country," said Nick Witney, senior research fellow at the European Council on Foreign Relations.

The combined group as it stands would eclipse US rival Boeing with sales of about 72 billion euros ($93 billion), based on 2011 numbers. It would total some 220,000 employees worldwide.

The deal would unpick the delicate ownership pact agreed for EADS since its creation in a 2000 pan-European merger. French media-to-aerospace group Lagardere owns 7.5 percent of EADS, with the French state holding 15 percent. German car maker Daimler holds 15 percent, with 22.5 percent voting rights.

The current status quo could be replaced by special shares for all three governments that would give them the power to veto any hostile takeover bid.

A Daimler spokesman said on Thursday that a merger could allow it to exit its stakeholding. Germany had already agreed, via state-owned bank KfW, to buy half of Daimler's stake to ensure the Franco-German balance.

"Since the planned transaction would also be linked to a possible dissolution of the shareholder pact, all options would be open to us in principle - including the possibility of selling our stake on the open market," he said by email.

German sources told Reuters the German government had yet to approve the merger, while France said it would wait before commenting. Yet one industry source said there were encouraging signs from both countries involved that a merger could go ahead.

French Industry Minister Arnaud Montebourg told France Inter radio he could not comment on the deal because of "reasons of confidentiality", but added that "this is a very important strategic, geo-strategic negotiation".

Diversified French conglomerate Lagardere said it would press for clarifications on the impact of the deal before giving it the go-ahead. But analysts suggested that it could see the move as a way of selling its stake to focus on other activities.

"Lagardere has wanted to sell its 7.5 percent stake in EADS for a long time, but internal constraints and the need to respect a French-German balance among shareholders have made a disposal difficult - especially as there is no obvious French buyer," Exane BNP Paribas analyst Charles Bedouelle said. - Reuters